Monopoly Chapter 7 Section 2 Market Structures Monopoly Chapter 7 Section 2

Market Structures Objectives: Describe characteristics and give examples of monopolies. Describe how monopolies are formed including government monopolies. Explain how a firm with a monopoly sets output and price, and why companies practice price discrimination.

Market Structures You go to the emergency room with a high fever and a sharp pain in your leg. The doctor diagnoses it as a rare infection. He prescribes a new medication (10 pills). You go to CVS and find out that the medicine costs $ 97.35 ($10.00/pill). The pharmacists tell you that only one company has the right to produce this medicine and it charges a high price because its scientists worked for years to develop this medication.

Market Structures The market for prescription medicines is one of many markets in which monopolies can develop.

Market Structures A Monopoly forms when barriers prevent firms from entering a market that has a single supplier. Monopolies have ONE seller. Any number of buyers. Barriers to entry are the principal condition that allows monopolies to exist.

Market Structures Monopolies can take advantage of their market power and charge high prices. This means that the quantity of goods sold is lower than in a market with more than one seller. For this reason, the United States has outlawed some monopolistic practices.

Market Structures All monopolies have one common trait – a single seller in a market. Different market conditions can create different types of monopolies.

Market Structures If a firm’s start-up costs are high, and its average costs fall for each additional unit it produces, then it enjoys what economists call economies of scale. Economies of Scale – characteristics that cause a producer’s average cost to drop as production rises. Companies without economies of scale – as output increases from zero, the average cost of each good drops, and the curve initially sloes downward. Eventually the average cost of production begins to rise as output increases because it has a rising cost per unit.

Market Structures i.e. Hydroelectric Plant It has a high expense to build. Once the dam is built, the plant can produce energy at a very low additional cost by letting water flow though the dam. As output increases, the fixed costs of the dam can be spread over more units of electricity, so the average cost drops.

Market Structures Natural Monopolies A market that runs efficiently when one large firm provides all of the output If a second firms enters the market, competition will drive down the market price charged to customers and decrease the quantity each firm can sell. One or both of the firms will not be able to cover their costs and will go out of business.

Market Structures Example of a natural monopoly is public water. In a competitive market, different water companies would have to dig their own well, run their own water pipes throughout town (city), and have their own pumping stations. Lead to a big mess in town & confusion

Market Structures In a case like this, the government steps in and allows just one firm in each geographic area to provide these necessary services. The government ensures that we don’t waste resources building additional plants when only one is needed.

Market Structures A firm with a natural monopoly agrees to let the government control the price it can charge and what services it must provide.

Market Structures Technology & Change Sometimes the development of new technology can destroy a natural monopoly. A new innovation can cut fixed costs and make small companies as efficient as one large firm. i.e. Used to be that no one wanted to put up all the wiring and all the poles to connect people by use of the telephone. Copper wire, etc. Than in the 1980s – consumers began using Cell Phones – changed people’s thinking

Market Structures Government Monopolies A monopoly created by the government. Barriers created by the government limit the entries into the market.

Market Structures Technological Monopolies One way to give a company monopoly power is by issuing a Patent – a license that gives the inventor of a new product the exclusive right to sell it for a certain period of time. If Leland Pharmaceuticals develops a new asthma medication called Breathe-Deep. If the researchers can prove to the government that they had invented this product, the Food & Drug Administration (FDA) would give Leland the exclusive right to sell this product for 20 years.

Market Structures Patents guarantee that companies can profit from their own research without competition. This is the reason that companies are encouraged to research and develop new products that benefit society. Costs are very high, but the patent allows firms to set prices that maximize their opportunity to make a profit.

Market Structures Franchises and Licenses Franchises – is a contract issued by a local authority that gives a single firm the right to sell its goods within an exclusive market. National Park Services – pick one single firm to provide food and other goods at all national parks in the US.

Market Structures License – the government grants firms the right to operate a business. i.e. – Radio and television broadcast frequencies. Issued by the Federal Communications Commission (FCC).

Market Structures Industrial Organizations Sometimes the government lets companies in an industry restrict the number of firms in a market. Major League Baseball and other sports restrict the number and location of their teams. Baseball can choose new cities for their teams and is not charged with violating the laws that prevent competitors from working together.

Market Structures Major League Baseball is exempt from these laws – antitrust laws – they were passed to break up an illegal form of monopoly known as a trust. Baseball owners are able to control a lot of what goes on in their sport (as well owners in other sports).

Market Structures Price Discrimination – division of customers into groups based on how much they will pay for a good. Price Discrimination is based on the idea that each customer has his or her own maximum price that they will pay for a good. If monopolists set the price of that good at the highest maximum price of all buyers in the market, the monopolist will only sell to the few customers will to pay that much.

Market Structures If the monopolist sets a low price, the monopolist will gain a lot of customers, but the monopolist will lose the profits he could have made. Price discrimination is practiced by companies who have market power – the ability of a company to change prices and output like a monopolist.

Market Structures Targeted Discounts Companies divide customers into large groups and design pricing policies for each group. Examples of Price Discrimination Discounted airline fares Airlines offer discounts to travelers who buy tickets several weeks in advance or are willing to spend a Saturday night at their destination.

Market Structures Business travelers would not prefer to spend a Saturday night at their destination, but these tickets are appealing to vacationers who wouldn’t otherwise pay to fly and don’t mind the restrictions.

Market Structures Manufacturers’ rebate offers Television, car, refrigerator, and other manufacturers will refund a small part of the purchase price to buyers who fill out a form and mail it back. People who take time to fulfill the rebate requirements are likely more price-conscious than those who don’t and may be paying full price.

Market Structures Senior citizens or student associations Many senior citizens or students have lower incomes than people who work full time. Zoos, theaters, and restaurants often offer discounts to these people because they are unlikely to be able to pay full price for what some consider luxuries.

Market Structures Children fly or stay for free promotions Families with young children spend more of their income on food, clothing, and school expenses. As a result, they have less to spend on vacations. Firms would rather have their business and earn lower profits than earn no profits at all, so they offer these discounts.

Limits of Price Discrimination For price discrimination to work, a market has to meet three conditions. Firms that use price discrimination must have some market power, customers must be divided into distinct groups, and buyers must not be in a position in which they can easily resell the good or service.

Market Structures a. Some market power – have some control over prices. b. Distinct customer groups – be able to divide groups into distinct groups based on their sensitivity to price. c. Difficult resale – it does not work if people can resell the goods for a profit. Usually, it will be for theme park admission, restaurants, etc.

Market Structures Sometime firms use price discrimination to drive other firms out of business. This is illegal – called predatory pricing